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State Name: New Jersey
State Name underscore: New_Jersey
State Name dash: New-Jersey
State Name lower underscore: new_jersey
State Name lower dash: new-jersey
State Name lower: new jersey
State Abbreviation: NJ
State Abbreviation Lower: nj

MND NewsWire features plain and simple interpretations of industry related data and events written in a manner that maintains the interest of random readers while still catering to the perspective of a housing market professional.

The
Federal Reserve Bank of New York has published a paper by one of its
former visiting scholars that flies in the face of the stated policy
of at least one federal regulatory agency and is bound to stir up
Wall Street interests once again. Paying
Paul and Robbing no One: An Eminent Domain Solution for Underwater
Mortgage Debt
by Robert Hockett, Professor of Financial and Monetary Law at Cornell
Law School, advocates a program of loan restructuring by state and
local government which has been specifically denounced by the Federal
Housing Finance Agency and drawn substantial fire from the private
sector.

Hockett says that,
in the view of many analysists, the best way to assist underwater
homeowners is to reduce the principal on their home loans but the
hurdles to principal write downs make this form of
modification used less than would be optimal. One is the
"last-mover" advantage that accrues to the creditors of
later loans when principal is reduced on earlier ones. Then the
Federal Housing Finance Agency (FHFA), conservator of the government
sponsored enterprises Freddie Mac and Fannie Mae, has flatly refused
to allow them to participate in write downs.

In the case of
privately securitized mortgages, such write downs are almost
impossible to achieve. The most decisive
structural barrier is that so many of the pooling and servicing
agreements require super-majority voting among the securities holders
before the loans can be modified or sold out of trusts. And these
investors, geographically dispersed and unknown to one another,
cannot collectively bargain with borrowers or buyers on workouts or
prices.

Moreover the agreements governing the loans prevent
trustees and servicers from modifying or selling off loans in the
requisite numbers. Finally the agreements typically stipulate
servicer compensation that make it more profitable for them to
oversee lengthy foreclosure proceedings than to pursue modifications.

There is the
additional complication of second liens on many of the properties.
First lien holders are rationally reluctant to modify their loans
unless second lien holders do so as well while second lien holders
often lack motivation to make concessions or have conflicts of
interests because of relationships with the servicer and/or first
lien holder.

The solution,
Hockett says, is for state and municipal governments to use their
eminent domain powers to buy and and restructure underwater loans.
He and two others separately advocated federal
eminent domain action in 2008, he says, but so far no such action has
been taken and most of the emphasis in helping homeowners has been in
the form of interest rate reduction and extended loan terms. Since
2007 little more than 1 percent of underwater loans have been written
down. This weak response, he says, is surprising in light of the
evidence that sizable write downs save value and that unmodified
underwater loans will default at high rates.

Since neither the
federal government nor the trustees of private label securities (PLS)
seem moved to be the collective agents in solving the problems, then
state and municipal governments appear to be in the best position to
do so. They face the consequences of mass foreclosures and have the
constitutional authority to address the structural issues.

Hockett suggests
that sub-federal governments use their eminent domain powers to
purchase underwater loans from PLS trusts at fair value, dealing
directly with trustees and sidestepping all contract "rigidities."
They can then write down the loan, reducing default risk and raising
expected values in the process. If need be, the eminent domain
authority can also be used to take the second-lien position at fair
value or just the liens that secure them, leaving the notes behind as
unsecured consumer debt.

Hockett has several
suggestions for "Financing the Refinancing." One would be
through federal monies lent in the manner of Treasury's Troubled
Asset Relief (TARP) or Public-Private Investment Programs, or the
Federal Reserves MBS stabilization programs, all of which turned
profits. Alternatively they might raise money from private investors
or a combination of federal and private funding which would be paid
back from the proceeds of the refinanced and accordingly more
valuable loans or from bonds issued against pools of the same. He
suggests that if private money is used, the current bondholders
should be given some prior claim to participation.

There
are a number of issues to be confronted; (a) the selection and
valuing of appropriate loans; (b) securing government and/or private
investors; (c) commencing the eminent domain procedures; (d)
modifying and possibly re-securitizing the loans; (e) working with
homeowners; and (f) compensating investors at appropriate stages.

Hockett
sees no legal issues with using eminent domain in this way; all types
of property has been secured in the past in this way - tangible and
intangible, contractual and realty-related alike. The question then
is whether the public purpose justifies the taking and whether fair
value is paid. The public purpose - "Preventing more
foreclosures, blighted properties, revenue base losses, and city
service cutbacks is recognized by courts as the most compelling of
public purposes justifying use of the eminent domain authority."

There
are many ways of setting value and it is not necessary to "rob
Peter to pay Paul". Eminent domain proceedings need not
represent zero sum games. The plan recoups value which can then be
equitably distributed to render all stakeholders better off. First,
lien holders who help finance the purchases from their PLS trusts
receive loans that are higher in expected value in exchange for those
with lower expected values.

First lien holders who do not so
participate receive fair value for otherwise unmarketable assets.
Homeowners gain modest equity and diminished default and foreclosure
risk. Neighbors see their communities, property values, and
municipal services stabilized, while municipalities see property tax
revenue restores and abatement costs drop. Even second lien holders
can benefit if paid a small fraction of the value of the asset.

The
concerns that will probably be raised fall under two headings,
Hockett says, those that debt write-downs always seem to raise - that
it induces moral hazard and reduces credit availability - and
concerns that the plan relies on state rather than federal authority.

The
question of moral hazard, he says, is a personal issue that he cannot
resolve but there seems to be little need to fear long-term
contraction in liquidity or credit. Bubbles inflate only when credit
is overabundant. The best way to get to safe middle groups is to
clear out the overhang of negative equity then to ensure that pooling
and servicing agreements mirror those in commercial MBS, anticipating
the possible eventual need to salvage value. It is also important to
remember, he says, that write-downs are done are mortgage debt all
the time. It is called bankruptcy.

Concerns
about using state rather than federal authority resolve around the
problem of lack of uniformity in application. While some degree of
national uniformity would be welcome, Hockett says, local conditions
do vary and so fairness itself dictates some variation. Federal
agencies, however, could be helpful in confining local variation
within reasonable bounds as well as promoting efficient and amicable
loan workout nationwide along lines like he proposes.

Hockett does not mention in his paper
that something very similar to the eminent domain proceedings he
suggests were recently announced by several cities and resulted in
cries of outrage, threats, and proposed legislation.

In June 2012 the
Board of Supervisors in San Bernardino County California announced
they would use their power of eminent domain to take underwater
mortgages from lenders and restructure them for borrowers at the fair
market price. Local governments in Chicago, Brockton,
Massachusetts and other cities quickly followed suit There was also
an almost immediate response from SIFMA, the trade organization
representing the securities industry. It announced it would litigate
any attempts to implement such programs and threatened that any
community that did proceed would effectively find itself, shall we
say, credit starved.

In
August FHFA posted a notice in the Federal
Register
inviting comments on the issue. The
notice said the agency had significant concerns about the use of
eminent domains to revise existing financial contracts and the
alternation of the value of GSE or bank securities holdings, and that
it had determined that it might need to take action both as
conservator of the GSEs and regulator for banks to avoid a risk to
safe and sound operations and avoid taxpayer expense. Any
action it might take was unspecified

The following
month Representative John Campbell (R-CA) introduced a bill titled
The
Defending American Taxpayers from Abusive Government Takings Act
which would prohibit the four major government sponsored mortgage
providers from buying loans in any community which used eminent
domain in such a way. In January San Bernardino announced it was
dropping the plan and the other communities have been very quiet.

It is interesting
to speculate on the Fed's reasons for publishing Hockett's paper.
Was it simply a scholarly attempt to air differing views on solutions
to the financial crisis, or was the Fed flexing a few muscles in the
direction of FHFA and Wall Street? Stay tuned.

Comments

At last a reasonable and legally acceptable way to help the underwater homeowners now being held captive by the "unscrupulous lenders and secondary CDO partners from Wall Street " who actually created the prior real estate price buble. These re-written underwater private mortgages today will allow these homeowners to both enhance the general economy by enhancing purchasing power as well as allowing them to become near future seller's and buyer's. It's been a long time coming; let's get started!

At some point a borrower must be accountable for their financial decsions and actions. Having no understanding of what you're signing up for is not a defense. Asking Banks to eat losses is a zero sum gain where all are asked to pay for the negligence of the few

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